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After graduating at 20 from the University of Massachusetts at Lowell, Rob Manning went to work for MFS Investment Management as an analyst of the steel industry's high-yield bonds. Now 49, Manning is CEO of the company, which manages $350 billion in assets.

When Manning took the top spot in February 2004, MFS was still struggling to recover from the dot-com bust of 2001, as well as its role in several late-trading and market-timing scandals that rocked the fund industry in 2003. MFS ended up settling with regulators after it was accused of a form of market-timing, which involved allowing some investors to trade in and out of funds rapidly to the detriment of longer-term holders.

"We had a massive debt problem globally. We are going to have
a volatile time for the next couple of decades." — Rob Manning
Jason Grow for Barron's

Manning's charge was to restore both trust and performance at the Boston-based company, which launched the first-ever mutual fund, Massachusetts Investors Trust (ticker: MITBX), in 1924. He has proved effective at both. He has built a global research operation, and put a premium on accountability and consistent performance across all of MFS' 82 funds. In testament to his success, MFS is one of only two fund firms in the 2012 Barron's/Lipper Fund Family Rankings to make it into the top 10 in the one-, five-, and 10-year rankings. (JPMorgan Chase [JPM] was the other.) Investors have noticed, sending a record $29.4 billion to MFS last year, 70% of which was invested in equities.

What does Manning expect for the firm, the industry, and the markets in the year ahead? He shares his insights and forecasts below.

Barron's: Let's begin with your view of the bond and stock markets. Where are they headed?

Manning: We had a massive debt problem globally, and we transferred it from the private sector to the public sector. So the problem never went away. We are going to have a volatile time for the next couple of decades.

Did you really say decades?

I did. We are going to have crises that shock the financial system around the world. As a result, it is going to be a stock picker's and a bond picker's market. You better be vigilant about having strong risk control in your portfolios.

So what does that mean for bonds?

The bond market is severely overvalued. Everything that is spread-based is priced off the 10-year Treasury, which yields less than 2%. In a normal environment, the 10-year Treasury should yield what the real growth is in the economy, plus expected inflation. Currently, that would be 4.5% to 5%. When I got into the business 30 years ago, interest rates were much higher, so the price sensitivity of a 10-year Treasury to a 1% rise in interest rates was less than half what it is today. When interest rates normalize, people are going to lose 25% of the value of their bonds.

All bonds, or just Treasuries?

It isn't going to matter whether you own a high-grade corporate bond, emerging-market debt, or high-yield securities. You are going to get hit. The bond market has all the risk, and you better be cautious about the amount of duration, or maturity, you are willing to take on. And you have to be vigilant about the credits you pick, because the spread isn't going to compensate you when bond yields normalize.

Are you more optimistic about equities?

The yield on the 10-year Treasury is less than 2%, but the earnings yield on the Standard & Poor's 500 is about 8%—that's higher than what you're getting on high-yield bonds. The S&P's price/earnings multiple is around 15. If you can buy high-quality companies with a global footprint that generate good returns on invested capital and have good market share and growth opportunities for the next 10 years, those stocks are going to kill bonds in terms of returns.

Yet investors are still pouring money into bonds.

Our inflows have been the reverse of the industry's, as we are getting almost 75% of our sales from equity products around the globe, and 25% from fixed income. The industry, on average, has seen the exact opposite. I'm concerned people are buying bonds because they think they're the safe alternative. In reality, all of the risk in the capital markets is in the fixed-income arena.

How do you, as a firm, navigate that kind of a shift?

You need three things to be a successful asset manager. First, you need an edge. You can't just hire a couple of smart M.B.A.s, lock them in a room for three years, cross your fingers, hope they generate good returns, and then sell that to clients. People want to know your institution is organized in a way that will allow you to deliver consistent and durable performance over a long cycle.

Second, you need global reach. We have analysts all over the world, organized in eight sectors, each of which has analysts for high-grade credit, junk-bond credit, equity, and some quantitative strategies.

Why the push to have research personnel overseas?

You have to have a global footprint. Because of the instantaneous information flow, you need to have local people in those markets. Other firms have beautiful maps showing their offices all over the world, but many of those people don't even know each other. The people in Japan have no idea who the people in Europe are or who the people in North America are. Our people not only know each other, they are working with each other weekly, and they are paid, in part, based on how well they work together.

OK, so what's the third quality needed for success?

Strong risk controls for the portfolios. We have tracking-error bands or volatility bands around all the portfolios. We also use what we call beta bands to figure out what a portfolio's risk can be relative to the market. And we make sure that all the portfolios are style-pure. If you are a large-cap value manager, you aren't allowed to buy small-cap growth stocks if that's what's working in the market.

The whole key to this business is consistency. You have to be above average every year. The tennis analogy I use is, don't make the unforced error; let the other guy do it. Just keep hitting the ball over the net, and have above-average returns. Do it in down markets; do it in up markets.

What sets a good analyst apart from the pack?

Good research means digging deep. Being a research analyst is a solitary job. You have to be wired a certain way to be good at it, because it is all about spending hours and hours reading and delving into the details. If you are a credit analyst, it means reading an indenture to understand what the covenants are and what legal provisions you have as a bond holder. If you are an equity analyst, it means doing channel checks with distributors to learn how a company is doing, and fact-checking to make sure that what you're hearing from management is accurate. We also have a proprietary note system, so we have hundreds of analysts running around the world meeting with managements and sharing data. It's about getting information fast and finding good ideas. It's also important to avoid bad ideas.

How do you compensate portfolio managers?

In a world where everybody is focused on the short term, we focus our portfolio-manager and analyst compensation on the long term. Three- and five-year performance weightings are significantly larger than the one-year performance weightings of funds. You accrue value in the compensation system here by longevity and consistency over longer periods of time. We call that time arbitrage.

How do you deal with funds that aren't working out?

If a fund's performance flounders, we will make a change in management or merge it. Our goal is to make sure we generate good returns across all of our products. Occasionally, we will launch a product and there just isn't demand for it and it doesn't get the scale it needs. If it isn't in our wheelhouse any more, we'll merge it or close it. But our product line is pretty broad and deep, and we haven't launched too many products in the past few years.

When you took over as CEO nine years ago, MFS had gone through a difficult stretch, partly owing to market-timing violations in several of its funds. What was that like?

I'm a blue-collar kid, and the day MFS hired me, I felt like I'd won the lottery. So when the firm had an issue I, almost like a parent, stepped in and said, "I've got to face this thing and see the company through." I'm a pretty tough guy. I grew up on the streets in Lowell, Mass., and my background is in high-yield and distressed-debt investing. I had to get into the ring and spar with some strong personalities, including clients, trustees, and members of the management team, in order to succeed in this role. But I was wired and trained to handle the situation I was given.

What were some changes you made?

MFS has always been a wonderful place to work, and we've had a good reputation. The company is humble, and people treat each other with respect. But sometimes that culture of cooperation and friendliness can lead to lackluster results. So I embedded a core principle of a meritocracy. I kept the essence of teamwork and humility and mutual respect that the firm always had, but we expect people to perform. And if you don't perform, you can't stay at the company.

Did you also put a higher priority on risk control?

Yes. Prior to taking over as CEO, I promoted Michael Roberge to president; later that year he also became chief investment officer and director of global research. He is one of the key people who implemented the risk process on the equity side of the firm. He and I are duplicates; we think exactly the same.

Why is that good?

We both came from credit backgrounds, so we understand an asymmetric payoff where, if you get it right, there is not a lot of upside, but if you get it wrong, you can lose a lot of money. We are both sufficiently paranoid, and we run the entire company with that risk view.

Where do you see MFS going from here?

We have about $345 billion of assets under management, with about $125 billion of it in U.S. mutual funds. Another $20 billion is in offshore mutual funds, and nearly $40 billion is in funds that we subadvise in variable annuities that we run for large insurance companies. The rest of it is our global institutional business. It's been our fastest-growing business. MFS had a record year last year. We had $89 billion in gross sales, and $29 billion in net sales, and we've had a strong start this year. Our performance across all distribution channels, products, and geography is strong, and we expect to continue to grow faster than the asset-management industry as a whole.

The value proposition of the hedge-fund world, particularly long/short equity, is very low for the client. Hedge-fund fees are astronomical. If one of our portfolio managers competes head to head against an alternative manager that is charging 2% [of assets] and 20% [of profits], plus high trading costs, there is no way they are going to beat us.

So why not package the hedge-fund strategies into a mutual fund?

We expect that the alternative world is going to morph into the mutual fund, long-only world, and that the better and more efficient way for institutions to get an alternative strategy is to put an overlay on top of a manager like us. Instead of shorting securities to reduce your net exposure to the market, you can use a swap or a derivative that costs you virtually nothing. As long as you have alpha, or outperformance, anybody can create whatever outcome they want off of that pool of return that you are giving them.

What's ahead for the U.S. retail fund industry?

It is a very good business. Mutual funds continue to be the choice for investors in DC [defined contribution] plans, and we expect that business will grow in the mid-single digits over time. We expect the entire industry to grow along with gross domestic product. At the same time, it is a mature business, and supercompetitive. You have to have scale and size. If you don't have scale and size, you aren't going to be able to attract and retain talent. And the costs of the business continue to rise, due to higher regulatory and distribution expenses.

How will the fund industry deal with those rising costs?

You also have to grow. If you aren't growing, you aren't going to keep your talented people, because you aren't going to be creating new products for them. You aren't going to have a bonus pool that is increasing. Employees at MFS own 20% of the company.

If you don't have performance and you aren't able to grow, it is going to be difficult to sustain the economics of the business. You are going to see more merger-and-acquisition activity as smaller shops have to pair up with bigger shops. A global platform is critical. There are a lot of domestic-based mutual-fund companies that don't have that, and they aren't going to be able to survive without it. There will be room for specialty small boutiques and for the big global players. But the in-between firms are going to get squeezed, and they are going to have a difficult time.